Distributive Politics and Economic Growth

1. Economic Growth Spring Semester, 2009 Benedikte Fogh Larsen Distributive Politics and Economic Growth Alberto Alesina and Dani Rodrik

2. Purpose of the article: • Focus directly on the relationship between distribution of resources and growth. • Attempt to determine whether initial inequality is a statistically significant predictor of long-term growth across countries.

3. Plan of the paper: • Section I: lays out the basic theoretical framework • Section II: presents the empirical evidence. • Section III: concludes.

4. Why is this relevant? • Redistributive policies introduce distortions, and thereby reduce growth. • But if an economy's initial configuration of resources affects long-run growth negatively -> scope for redistribution. • Look at the trade-off faced by welfare states

5. Clarification of terms • Tax on capital: interpreted as a metaphor for any kind of redistributive policy that transfers income to unskilled labor while reducing the incentive to accumulate. • Labour = unskilled labor • Median-voter theorem: simply captures the basic idea that any government is likely to be responsive to the wishes of the majority when key distributional issues are at stake.

6. Theory • Simple endogenous growth model with labor and capital as the primary factors of production • Appeal of this model: it attributes a constructive role for government. • Redistributive policies will interact with growth-enhancing policies. This feature is realistic: fiscal redistribution often takes place through various spending programs above and beyond direct cash transfers.

7. The tax model • Model of a particular policy instrument (a tax on capital income) and a particular channel through which this instrument enhances labor income (government spending on productive services) • Tax on capital plays two critical roles in this model: • -it affects the net return to owners of capital • -increases the instantaneous level of wage income because a higher rate of taxation allows the government to increase its spending on services that increase productivity.

8. Median-voter Theorem • In a perfectly egalitarian society everyone has the same labor/capital share, that is, = vi = the for all i. • Express individual i’s income as inversely related to • Consequently, the larger the gap between Um and unity, the larger the gap that will exist between median and average incomes. • The higher is Um above unity, the lower is the rate of growth of the economy. • The more unequal is the distribution of income and wealth, the lower is the rate of growth. In the context of our model, "inequality" is given by how poor is the median relative to the average voter.

9. Democracies vs. Dictatorship • The model should be more directly applicable to democracies, where voting plays a significant role in policy making. • However, dictators' policy decisions are also influenced by social demands and social conflicts. • Weight placed on growth in a dictatorship would depend on the nature of the regime and its preferences. • The model does not imply any type of correlation between regime type (democracy versus dictatorship)

10. Empirical Evidence • The basic implication of the model is that the more unequal is the distribution of resources in society, the lower is the rate of economic growth. • The link between distribution and growth is given by redistributive policies. In less equal societies more redistribution is sought by a majority of the population. • However, redistributive policies, in turn, reduce growth by introducing economic distortions.

11. The Data • Comparable data on wealth distribution for a large enough sample of countries do not exist -> use distributional indicators on income and on land. • Problem with data for developing nations • The problem of data quality is less acute for developed countries. Thus define and use a "high quality sample" that includes all the OECD countries for which there is data. • Present results for a larger sample, which includes all countries for which there is distributional data.

13. Comments on Table I • Results for the 1960-1985 period. • The results indicate that income inequality is negatively correlated with subsequent growth • Either one of the two Gini's coefficient is statistically significant at the 5 percent level or better and has the expected (negative) sign. • The coefficient for democracy is not statistically significant, rejecting the hypothesis that the relationship between inequality and growth is different in democracies and non-democracies.

15. Comments on Table II • Results for the 1970-1985 period • The results are even stronger: • The coefficient on the Gini is consistently significant at the 5 percent level or better. • Moreover, both the land and income Gini's remain statistically significant (at the 1 percent and 5 percent levels, respectively) when they are entered jointly.

16. Concluding Remarks • The basic message of the model is that there will be a strong demand for redistribution in societies where a large section of the population does not have access to the productive resources of the economy. • Conflict over distribution will generally harm growth • Results indicate that inequality in income and land distribution is negatively associated with subsequent growth.